Countrywide not written off yet

Shares fall, but analysts say the lender could survive credit crunch

By

MurrayColeman

GregMorcroft

SAN FRANCISCO (MarketWatch) -- Is the largest U.S. home lender down for the count?

Countrywide Financial Corp. spooked investors on Friday after the Calabasas, Calif.-based company said that problems in the U.S. mortgage market pose a serious threat to its earnings and financial condition.

But such drama is nothing new for this company. Shares of Countrywide
CFC, -4.22%
have been volatile, often lagging both the broader market and their peers for extended periods.

Its total returns, which count price movement and dividends, are down more than 3% on an average annualized basis during the past three years, according to Morningstar.

Most of those losses before this year came in 2005, when returns dipped 6%. That was an abrupt departure from past cycles. In 2002, while the broader market was diving, Countrywide's star was bright on Wall Street as it racked up gains of 27%. In the next year, those surged to 97% and then tapered to 48% in 2004.

Residential mortgages have been rocky since then, though. "When interest rates were really low and coming off historically high levels, everyone in America wanted to refinance their mortgages," said Frederick Cannon, an analyst at Keefe, Bruyette & Woods. "As the leading mortgage bank in the U.S., Countrywide was one of the biggest benefactors of the refinancing boom."

A key rival is Wells Fargo & Co.
WFC, +0.80%
Its shares also have been impacted during the recent meltdown, though not nearly as much as Countrywide's, which dropped in Friday's topsy-turvy session as much as 14% before recovering at the close to end down 80 cents, or 2.8%, at $27.86.

But unlike Countrywide, San Francisco-based Wells Fargo is diversified into full-service financial services, ranging from asset management to corporate lending.

Wells Fargo is also less dependent on Wall Street financing than Countrywide, according to Cannon. "While Countrywide has a growing banking operation that's important to its future, it's still predominately a mortgage bank that sells to the secondary markets."

Wells Fargo's mortgage-lending revenue is estimated by analysts to account for anywhere from 15% to 30% of their overall business. It doesn't break out those numbers in its financial statements.

So far in 2007, Countrywide's returns are down more than 30%. Almost all of those losses have come in the past three months.

Meanwhile, Wells Fargo's stock is down less than 2% this year. In the past three months, its shares have lost close to 6%. But over the past three years, the diversified banker has generated total returns of better than 10% on an average annualized basis.

"Wells Fargo is a much more diversified play and an extremely well-run bank," said Ryan Lentell, a Morningstar analyst.

But he added that Countrywide is a much better bargain these days than Wells Fargo. Morningstar estimates that Countrywide is trading now at about a 45% discount to its intrinsic value. Its analysts view Wells Fargo selling for 13% less than its $39 "fair value" price.

"There's more risk in Countrywide now," Lentell said. "In the next few months, it's going to be a pretty bumpy road for the company."

Comeback story?

HomeBanc Corp., a smaller mortgage player, filed for bankruptcy Friday. That came after it sold five offices to Countrywide earlier in the week.

"Countrywide is picking up assets from smaller players and gaining market share," according to Lentell. "They're one of the most well-capitalized mortgage originators in the country."

He said that Countrywide should make it through the ongoing unwinding in credit markets. "They've got a strong balance sheet, and market turmoil will diminish in coming weeks and months. As this situation winds down, we think Countrywide will be left standing as an even bigger player in the U.S. mortgage market."

Even though it can prosper as smaller competitors falter, Countrywide is subject to the same fundamental issues facing all mortgage lenders.

As an operator focused so heavily on mortgages, the firm has to rely on funding from large brokerages and investment banks. Most of its loans are packaged and resold on Wall Street. During that process of securitization, the lender has to cover its loans before those pools of mortgages can be distributed.

Of Countrywide's $200 billion-plus of liabilities, more than $125 billion came from outside borrowing, according to the company's second-quarter earnings statement.

But the markets' reluctance to buy mortgages right now is causing it to retain a greater proportion of mortgage loans than it sells.

In simple terms, this means that investment banks, the firm's traditional customers, are not buying the company's product. That figures to take a bite out of future earnings or revenues, or both.

The Federal Reserve took action Friday, acknowledging to a large degree the difficulty that Countrywide is talking about, announcing that it pumped $19 billion into the market in an effort to provide liquidity. See related story.

Countrywide's shares fell $5.11, or 17.8%, to $23.55 before the opening bell; the stock recovered somewhat by midday, down about 6% to $26.95.

Despite a slowing from the refinancing boom, Countrywide's stock is coming off a 26.2% return in 2006. In fact, earlier this year, the stock had been on the rise.

Part of that was credited to speculation that Countrywide was ripe for a buyout. One of the candidates talked about was Bank of America Corp.
BAC, +1.02%

Those whispers in the market have all but died as mortgage markets tank and credit tightens. Even though it could be viewed as more reasonably priced, Countrywide would still represent a rather large takeout. The firm still has more than $200 billion in assets and a market capitalization topping $15 billion.

'[Countrywide's] challenge is to get through this liquidity crisis and adjust operations to the new market reality.'
Frederick Cannon, Keefe, Bruyette &amp; Woods

Hostile takeovers in financials are also hard to pull off, analysts say. Countrywide's chief executive and co-founder, Angelo Mozilo, has said that management is committed to steering the firm through the current downturn.

Keefe, Bruyette & Woods' Cannon commented that uncertainty is so high right now that "it's hard to recommend that investors step into it at this point."

But he said: "We do think Countrywide will get through this and remain a leader. ... Its challenge is to get through this liquidity crisis and adjust operations to the new market reality."

Still, Cannon isn't recommending that new investors climb aboard just yet. He said that he remains neutral on the stock until the impact of a shakeout in mortgage markets becomes clearer.

Analysts at Merrill Lynch said Friday that the firm has the financial strength and management talent to survive what's a difficult market.

"We think CFC has the financial strength and management acumen to succeed, and we think Monday's disclosure that it would buy retail branches from a small lender for pennies on the dollar suggests it is not overwhelmed by the secondary-market gymnastics that is wreaking havoc on weaker names," Merrill told clients. See related story.

In a filing Thursday with the Securities and Exchange Commission, Countrywide said that while it plans to retain more loans until investor demand improves, it warned that a prolonged period of poor conditions "could have an adverse impact" on future profits and its financial condition.

"Based on our review of the risk section [of the filing], the aftermarket move seems to be an overreaction and we would recommend investors to accumulate stock on share price weakness," Merrill wrote.

The disclosure was made as part of Countrywide's regular quarterly financial report with the SEC.

When it announced second-quarter results in July, Countrywide indicated that widespread troubles in the subprime-mortgage market had spread to higher-quality loans. See related story.

At that time, Countrywide said that it expected the general slowdown in the housing market to last at least until 2009.

The same concerns are rattling the broader markets as well.

U.S. stock-market futures were pointing to another dark day of trading Friday following the plunge in the previous session, with central banks overseas pumping roughly $100 billion more into the banking system at a time of market worries. See full story.

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